Multifactor productivity change in the air transportation industry: productivity increases in the U.S. airline industry--the Nation's primary intercity mass transportation system--have played a significant role in the industry's cost-containment efforts and its ability to accelerate growth.

The U.S. air transportation industry is a key component of the U.S.
economy. About 42 percent of all passenger trips with roundtrip distances of between 1,000 and 1,999 miles are taken by plane. This
percentage increases dramatically to 75 percent if the roundtrip
distance is at least 2,000 miles. (1) Advances in technology that led to
the development of modern jets, along with the Airline Deregulation Act enacted by Congress in 1978, have allowed the U.S. airline industry to
become the primary intercity mass transportation system in this country.
The air transportation industry is important to our national economy,
but it faces unprecedented challenges. (2) The economic downturn that
began in early 2001 and the terrorist attacks of September 11, 2001, led
to reduced demand for air travel thereby resulting in decreased
profitability or losses for many companies. (3) These trends highlight
the importance of controlling costs in the industry, and over the last
three decades, productivity has played a significant role in the
industry's ability to control costs and to accelerate growth.

For many years, the Bureau of Labor Statistics (BLS) has published
a measure of labor productivity for air transportation. This article
discusses and analyzes a new BLS measure of multifactor productivity for
the air transportation industry, coded 481 in the North American Industry Classification System (NAICS), covering the period 1972 to
2001. This measure is consistent with the new definition of the air
transportation industry under NAICS in which air couriers are no longer
included in air transportation, but classified in NAICS 4921, couriers,
instead.

Labor productivity relates output to the labor resources used in
its production. It is an indicator of the efficiency with which labor is
being utilized, an important indicator of economic progress. Despite its
widespread use, a labor productivity measure should not be interpreted
as representing only the contribution of labor to production. Changes in
output per hour (or productivity) reflect a wide range of influences,
including changes in technology, skill and effort of the workforce,
organization of production, economies of scale, and the amount of
capital per hour and intermediate purchases per hour. Labor productivity
is a frequently used measure of economic performance. It is recognized
by researchers as an important tool for monitoring the health of the
economy. Over time, growth in real per capita income and increases in
living standards tend to follow growth in labor productivity. Higher
productivity growth increases the competitiveness of a business,
industry, or nation. Moreover, labor productivity serves as a buffer
against higher labor costs by offsetting part or all of the growth in
compensation per hour.

Whereas labor productivity relates the change in output to the
change in one input--labor--multifactor productivity relates the change
in output to the change in a combination of inputs. Growth in
multifactor productivity can be seen as a measure of economic progress;
it measures the increase in output over and above the gain due to
increases in a combination of inputs. The combined inputs measure is a
weighted average of labor hours, capital services, and intermediate
purchases. (4) The weights represent each input's share in the
total cost of output. Although the amount and complexity of the data
required to calculate a measure of multifactor productivity are much
greater than those for a labor productivity series, a multifactor
productivity measure yields valuable insights into efficiency beyond
those derived from a labor productivity measure. For example, in air
transportation, the expansion in the stock of widebody fleet in the mid-
1970s seems to be behind the productivity increase that is unrelated to
load factors. (5) Similarly, because energy costs comprise a large part
of intermediate purchases, "... the omission of this input
component would seriously degrade the true measure of productivity
trends." (6) Multifactor productivity reflects many of the same
influences as the labor productivity measure, but by explicitly
accounting for inputs of capital and intermediate purchases, the
multifactor productivity residual reflects only changes in overall
efficiency that are due to other unmeasured influences.

This article describes the patterns of multifactor productivity and
labor productivity change in air transportation since 1972 and the
sources of labor productivity change--namely, changes in multifactor
productivity, capital intensity, and intermediate purchases intensity.
It looks behind the aggregate data to describe output and the use of the
productive factors--labor, capital, and intermediates--in this industry
and how they have changed over time. The current situation in the
industry is briefly discussed.

Overview of productivity change

Productivity trends in air transportation and the private business
sector. Multifactor productivity in the air transportation industry
increased at an average annual rate of 2.0 percent over the 1972-2001
period, almost triple the 0.7-percent rate for the private business
sector as a whole (see chart 1). The labor productivity growth rates were not nearly as different, at 2.4 percent per year for air
transportation and 1.7 percent for the private business sector.
Multifactor productivity in air transportation decelerated from a very
high average annual gain of 5.1 percent during the 1973-79 period to a
0.8-percent gain from 1979 to 1990, and it rebounded back to a
2.1-percent growth rate during the first half of the 1990s. The growth
rate in labor productivity followed a similar pattern, dropping from an
average of 5.6 percent during the first period to 1.6 percent during the
second period, and increasing to a 4.2-percent average annual growth
rate during the early 1990s. This was a very different pattern of
productivity growth than that of the private business sector.
Multifactor productivity in the private business sector showed almost
identical growth rates in the 1973-79, 1979-90, and 1990-95 periods (0.6
percent, 0.5 percent, and 0.6 percent respectively). It then accelerated
to 1.3 percent from 1995 to 2000. The 1990-2000 period, which represents
a complete business cycle, is broken into two sub-periods to highlight
the widely-noted business sector productivity speedup in the last half
of the 1990s. The airline industry, however, did not experience a
productivity speedup in either labor productivity or multifactor
productivity from the first half of the 1990s to the second half.

A substantial part of the labor productivity speedup in the private
business sector during the late 1990s can be attributed to the effects
of improvements in the use of information processing equipment and
software (IPES) capital. Unfortunately, the data do not permit
separating out IPES capital for airlines. The contribution of capital
intensity as a whole is small for airlines, with an increase of only 0.2
percent per year over the entire 1972-2001 period and no growth in
capital's effect from 1995 to 2000.

In 2001, multifactor productivity in the air transportation
industry experienced a large decline of 4.2 percent (see table 1). Labor
productivity also declined at a substantial 6.4-percent rate, the
largest decline over the period studied in this article. Output dropped
6.6 percent, while combined inputs fell only 2.5 percent. A recession
occurred from the first quarter to the fourth quarter of 2001, and
multifactor productivity in the private business sector declined also,
although labor productivity increased. Both labor productivity and
multifactor productivity for airline transportation declined in previous
years around recessions (1980, 1981, and 1990 or 1991)--but the 2001
declines were the largest and second largest, respectively. Airlines in
2001 also were strongly affected by the events of September 11. Data for
2001 from the Air Transport Association of America (ATA) indicate that
airline traffic grew a modest 2.8 percent in the first quarter, with no
change during the second quarter. (7) After the terrorist attacks,
however, operations were completely shut down for 4 days. (8) Air travel
fell dramatically thereafter, resulting in declines of 7.8 percent and
19.0 percent for the third and fourth quarters, respectively. (9)
Overall, the September 11 attacks, along with the economic recession
that began in March 2001, caused a reduction in domestic airline
capacity--obtained by multiplying the number of seats available for sale
by the number of miles flown---of 3.0 percent in 2001. (10) Labor
productivity rebounded (up 12.2 percent) in 2002. Labor hours were
reduced by 11.6 percent, but output fell only 0.8 percent. Data for
multifactor productivity, capital input, and intermediate purchases
input are not yet available for 2002.

The sources of growth in labor productivity. Labor productivity
growth can be decomposed into multifactor productivity growth plus the
effects of changes in capital and intermediate purchase inputs relative
to labor. The influence of capital on labor productivity is referred to
as the "capital effect," which is measured as the rate of
change in the capital-labor ratio multiplied by the share of capital
costs in total output cost. Similarly, the influence of intermediate
purchases on labor productivity is referred to as the "intermediate
purchases effect," and is measured as the rate of change in the
intermediate purchases-labor ratio multiplied by the intermediate
purchases' share in total output cost.

Chart 2 shows labor productivity in air transportation and its
decomposition into the capital effect, the intermediate purchases
effect, and multifactor productivity for the 1972-2001 period and
several sub-periods. Among these three components of labor productivity
change, the largest contributor during the overall 1972-2001 period was
multifactor productivity, accounting for more than 80 percent (2.0
percentage points) of the 2.4-percent average annual growth rate in
labor productivity. The effects of capital and intermediate purchases
accounted for the difference, each contributing about one-half of the
remaining change in labor productivity--0.2 and 0.3 percentage points,
respectively--over the period.

The average annual growth rate in the capital effect remained at
0.2 percent during the first two periods. It then increased to 0.4
percent in the early 1990s but fell back to no growth during the
1995-2000 period. The intermediate purchases effect was modest in both
the 1973-79 and the 1979-90 periods, although it rose from an increase
of 0.3 percent to a rise of 0.6 percent. It then jumped to an average
gain of 1.6 percent per year in the early 1990s but fell by 1.1 percent
in the late 1990s.

Output

Changes in output in the air transportation industry respond to
many factors, including Federal legislation, competition among the
airlines, and the increasing influence that regional jets are having on
air travel, particularly among business travelers who account for 70
percent of regional jet passengers. (11) The general state of the
economy also plays a role. As evidenced by recent events, output also
can be affected by fears of air travel due to terrorism, health issues
such as the 2002 outbreak of severe acute respiratory syndrome (SARS),
and international conflicts such as the war in Iraq.

Output in the airline industry is comprised of passenger services,
as measured by passenger miles, and cargo services, as measured by
ton-miles. (See the appendix.) Passenger miles is by far the largest
component, making up more than 90 percent of total revenue, with the
remainder attributable to ton-miles. Although the output measure does
not account for changes in service quality such as flight delays and
route circuitry, some recent studies seem to indicate that such changes
did not significantly affect output and productivity. (12)

Real output in the air transportation industry almost quadrupled
over the 1972-2001 period, an average annual gain of 4.8 percent,
compared with a 3.4-percent average annual increase in the private
business sector. Output in the airline industry exhibited a cyclical pattern, although it also has been influenced by factors other than the
business cycle. From 1973 to 1979, output expanded at an average of 7.6
percent per year. This rapid growth in output, however, masks
considerable variation during the period. For example, from 1973 to
1975, the air transportation industry struggled as the fuel crisis, and
a continuing economic recession, hit hard throughout the economy; output
actually declined 0.3 percent per year during this sub-period.

From 1975 to 1979, an upturn in the Nation's economy and
industry deregulation (1978) led to a resurgence of traffic growth, and
output accelerated to, an impressive average annual growth of 11.8
percent per year. The industry set new traffic records in 1978 and 1979,
as output increased 14.0 and 15.8 percent, respectively. Under
deregulation--which allowed changes in routes and fares, and the
formation of new airlines--price competition, route restructuring, and
new airline formation became driving forces in the reduction of operator
costs. Airlines made changes to increase the efficiency of their
operations. For example, under government regulation, airlines were
forced to fly directly to remote or small markets, often with nearly
empty flights. (13) Although convenient for the few who lived in those
areas, this proved to be very inefficient for the carriers, given that
the cost to fly a plane is about the same whether it is empty or full.
Therefore, deregulation led to the development of widespread
hub-and-spoke networksJ4 This allowed the airlines to serve many more
markets than they otherwise could, with the same number of planes, if
they offered only point-to-point flights. (15)

Under regulation, with price competition restricted, airlines often
engaged in competition based on the level and quality of service. This
resulted in overuse of labor and materials inputs. (16) With the new
hub-and-spoke networks, the airlines could achieve higher load factors
in the smaller markets, which could result in lower operating costs and
lower fares. "According to one respected source, deregulation was
responsible for 58 percent of the price cuts from 1978 to 1993 and made
fares 22 percent lower than they would have been without
deregulation." (17)

From 1979 to 1990, output in the air transportation industry
expanded at 4.8 percent per year on average. The overall growth rate in
output for this period also obscures some variability in the interim
years, although not as pronounced as that during the 1973-79 period. For
example, the inflation, soaring fuel prices, and the general economic
situation facing the United States from 1979 to 1981 yielded output
declines of 3.6 percent and 2.2 percent in 1980 and 1981, respectively.
In fact, in 1980 the industry recorded the sharpest drop in traffic in
more than 50 years of scheduled air transportation. (18) In 1982, the
decline in passenger traffic began to reverse, and output managed to
accelerate rapidly to an annual average of 8.0 percent from 1981 to
1986. The commercial airline industry set passenger traffic records,
year after year, during the last 4 years of this period (1982 to 1986).
(19) The demand for air cargo services also grew significantly from 1981
to 1986, with records set during 3 of the 5 years. In 1987, the demand
for commercial air transportation continued its growth, as new records
were set for passengers, revenues, employment, and aircraft on order.
(20) Overall, output posted a rise of 4.9 percent per year during the
1986-90 period.

For the overall 1990-2000 decade, output grew an average of 4.2
percent per year, climbing by 3.5 percent during the first half of the
period (1990-95), and accelerating slightly to 4.9 percent during the
second half (1995-2000). Output in the airline industry declined in
2001. Prior to September 11, average domestic airfares had already
fallen sharply in response to the weakening economy, reduced business
travel, and an increasing proportion of low-margin leisure travelers.
(21) The September 11, 2001, terrorist attacks further exacerbated a
weakened air transportation industry by forcing it to briefly shut down
its operations. The airlines cut capacity over the last 4 months of
2001, although the month-to-month reductions in capacity slowed from a
high of 19 percent in September to 10 percent in December. (22) Output
for 2002 as a whole declined slightly, by 0.8 percent, from 2001.

Inputs

Labor. Employment in the air transportation industry almost doubled
from 294,600 in 1972 to 575,500 in 2001. (23) During the same time
period, output almost quadrupled. Between 1973 and 1979, employment
increased relatively slowly at an average annual growth rate of 1.9
percent, although output expanded at a rapid 7.6 percent per year. After
the Airline Deregulation Act of 1978, however, the industry went through
a period of adjustment. By 1984, the number of scheduled interstate
carriers had increased from 36 to 123, providing a variety of
competitive options to air travelers and shippers. (24) The entry of
these new carriers into the industry put downward pressure on fares and
strongly contributed to a 3.2-percent average annual employment increase
from 1979 to 1990, as output climbed 4.8 percent. During the 1990-2000
decade, employment growth in the air transportation industry slowed
markedly to an average 1.8 percent per year. Employment declined by a
slight 0.2 percent in 2001, then dropped a substantial 11.6 percent in
2002. Part of the slowdown in the 1990s was spurred by increased
customer use of Internet Web sites for air travel planning. These Web
pages have grown increasingly more sophisticated, allowing travelers to
do almost everything related to their travel, from checking the status
of their frequent-flyer accounts, to booking flights and selecting their
own seats. With this increased Internet use by customers, airlines have
been able to reduce the number of customer service agents needed to
handle bookings and flight information questions. In addition to being
able to book their own flights, once travelers arrive at the airports
across the country, they can take advantage of the self-service kiosks
provided by the airlines, which have grown in popularity since their
introduction in 1995. These kiosks allow the passengers to get boarding
passes for originating or connecting flights; select seats; request to
stand by for an upgrade; check baggage; and change flights, among ether things. (25) The increased use of self-service kiosks has given airline
carriers the flexibility to lower their costs by using fewer customer
service agents at the airports.

Although flight crew members, which include pilots and flight
attendants, are highly visible employees in the airline industry, they
comprise only about 30 percent of total employment. (26) The majority of
employees in the industry work in "ground occupations." In
addition to reservation and transportation ticket agents and customer
service representatives, their occupations include aircraft mechanics,
service technicians, and baggage handlers, among others.

Capital services. The air transportation industry requires a large
amount of physical capital in order to provide services. Because most
capital equipment is financed through loans or the issuance of stock,
establishments in this industry need to maintain healthy levels of
profits and cash flows to meet their debt obligations or to acquire,
through leases or purchases, aircraft and other capital equipment. The
capital measure consists of the flow of services provided by these
capital goods, which include items such as aircraft, engines, food
service equipment, baggage handling equipment, computers, ticket and
boarding pass issuing and reading equipment, and other ground equipment.

The air transportation industry has experienced rapid growth since
its origins dating back to the Contract Air Mail Act of 1925, and this
growth has been accompanied by growth in the quantity and complexity of
the capital stock. A number of important technological
innovations--before and during regulation--made airplanes safer, faster,
and more efficient, helping to attract passengers away from other means
of transportation such as railroads. The 1938 Civil Aeronautics Act,
which helped maintain order in the industry, "... coupled with the
tremendous progress made on the technological side, put the industry
firmly on the road to success." (27) Moreover, during WWII, new
technologies such as the gas turbine engine revolutionized the air
transportation industry and laid the groundwork for a tradition of
continued technological change in the decade that followed. (28) The new
technologies that were available entering the post-WWII period, coupled
with the extensive engineering and flying skills developed during the
war--and the resulting production facilities that existed--created an
increased public acceptance for air travel. (29) As air travel soared
following the war the skies got more crowded and safety became a serious
issue, prompting Congress to create the Federal Aviation Agency in 1958
(predecessor to the Federal Aviation Administration). The new agency was
in charge of establishing and running an air traffic control system, as
well as overseeing all other aviation safety matters. The 1950s also saw
important innovations in airport and airway technologies such as
Instrument Landing Systems (ILS), approach lighting systems, and the
navigational aid VORTAC (VHF Omni directional Range with Tactical Air
Navigation), which transmits a signal allowing an aircraft to determine
its bearing. (30) In the 1960s, all major airlines were replacing their
aging piston-engine types with jet aircraft. "Boeing 707s, DC8s,
Convair 880s and VC10s replaced the earlier DC7s, Stratocruisers, and
Constellations on the long-haul routes. Boeing 727s, Caravelles, DC9s,
BAC111s and Tridents replaced the piston-twin types on medium and
short-haul routes." (31) The introduction of these jet aircraft
sharply reduced the time and cost of transporting passengers and
freight. According to a study by Robert Gordon, labor productivity in
the commercial airline industry increased at an average annual rate of 7
percent during the 1960s, which was significantly higher than that of
the U.S. economy as a whole. (32)

Between 1972 and 2001, the flow of services from capital stock
increased rapidly at an average annual rate of 4.2 percent. This growth
rate is consistent with a rapid output growth of 4.8 percent per year.
Over the same period, the cost of capital services averaged 11.5 percent
of total costs (see chart 3.) The share in total costs comprised by
capital may seem low. However, airline assets have long service lives;
therefore, replacement costs per dollar of stocks are lower than in most
other industries. In addition, some "capital" such as airport
terminal space is rented and counted in intermediate purchases rather
than in capital, although this is not the case for leased aircraft,
which are included in the capital input measure. By 2001, capital input
had more than tripled from the 1972 level.

Growth in capital input accelerated from a 3.5-percent average
annual rise during the 1973-79 period to a 5.3-percent average annual
gain from 1979 to 1990. This increase in the growth rate of capital
occurred despite a falloff in the growth of output, which dropped from
an average increase of 7.6 percent in the first period, to 4.8 percent
in the latter period. During the 1970s decade, widebody
'Jumbo' jets--such as Boeing 747s, Douglas DC10s, and Lockheed
L1011 Tristars--were introduced into service. With their very large
size, the jumbo jets provided economies of scale that allowed for more
travelers to fly for a lower cost. The Boeing 747, for example, could
seat as many as 490 passengers and reach speeds of up to 604 miles per
hour. (33) As the number of jumbo jets in the industry increased in the
mid-1970s, the productivity gains that were not related to load factors
seem to have been significantly influenced by the expansion of this
fleet of large capacity airplanes. (34) The 1970s also saw the
introduction of the second generation of jet airliners, such as
Airbus' A300-600 and Boeing's 737-100 and 200, for medium and
short haul routes. The A300-600, a medium range widebody airliner,
featured a two-crew EFIS (Electronic Flight Instrument Systems) cockpit,
with digital avionics. (35) During the 1980s, new aircraft were
introduced with more powerful but quieter engines. For example, the
Boeing 737-300, 737-400, and 737-500--with the CFM56 engine (made by
General Electric/Snecma)--were produced.

Other airliners that entered the industry in the 1980s include
Boeing's 757 and 767, which were developed in tandem and share a
number of systems and technologies--including a common early-generation
EFIS flightdeck that integrated the functions of dozens of separate
instruments to simplify cockpit scan, thus reducing pilot workload and
fatigue. Since their introduction, the evolution of EFIS systems have
allowed operators to benefit from more capability, flexibility, and
redundancy with increased reliability. (36) Airbus introduced the A310
and the A320. The A320, a short to medium range airliner, is the first
plane to introduce a fly-by-wire flight control system, under which
control inputs from the pilot are signals rather than mechanical
processes. (37) A fly-by-wire system is built to interpret the
pilot's intention and translate it into action, a translation
process that takes environmental factors into account first. (38) The
advantage of this type of system is that it is computer-controlled,
making it virtually impossible to exceed certain parameters such as G
limits and maximum and minimum operating speeds.

The flow of services from the capital stock fell to an average
annual rise of 3.4 percent during the 1990-2000 decade, as output
continued to expand by 4.2 percent per year. In 2001, capital input
increased 4.5 percent, while output declined 6.6 percent. The most
noteworthy commercial aircraft introduced in the United States in the
1990s were those in the Boeing 777 jetliner family. "Notable 777
design features include a unique fuselage cross section, Boeing's
first application of fly-by-wire, an advanced technology glass
flightdeck with five liquid crystal displays, comparatively large scale
use of composites (10% by weight), and advanced and extremely powerful
engines." (39) It was designed as a replacement for the early
generation 747s; and although their passenger capacities are comparable,
it burns one-third less fuel, and it features 40-percent lower
maintenance costs. The development of large turbofan (fuel-efficient)
engines during the 1990s is particularly important for airline
establishments, given that fuel represents their second largest expense,
exceeded only by labor. The Boeing 777-300 can seat up to 550 passengers
in a single-class high-density configuration.

A closer look at the 1990-2000 period shows that during the first
half of the decade (1990-95), capital services grew at a moderate rate,
increasing by an average of 2.6 percent per year, while output
maintained a moderate growth of 3.5 percent. During the 1990-91 period,
the United States was experiencing a recession, coupled with the
conflict in the Persian Gulf. In 1991 alone, the air transportation
industry experienced an output decline of 2.1 percent, the largest in a
decade, along with a 2.9-percent drop in employment. The industry
recorded an employment decline of 0.7 percent per year, on average,
during the entire 1990--95 period. The economic downturn that led to
financial losses in 4 of the 5 years between 1990 and 1995 caused the
air transportation industry to accumulate debt and to scale back on
capital acquisitions. The industry was faced with the difficult task of
meeting its capital needs as it tried to replace its oldest, noisiest
jets with newer environmentally-friendly technology. (40) In 1995, the
commercial airline industry began to recover financially and posted its
first net profit after 5 years of losses. During the second half of the
decade (1995-2000), the growth rate in capital services in the air
transportation industry rebounded to an annual average of 4.1 percent,
as output grew rapidly at 4.9 percent per year. The industry experienced
net operating profits every year during this period.

Intermediate purchases. Intermediate purchases include the
materials, fuels, electricity, and purchased services used in the
production of the industry's output. Purchases of intermediate
materials grew by 2.8 percent per year from 1972 to 2001. Intermediate
purchases grew moderately at an average annual rate of 2.6 percent from
1973 to 1979, then accelerated to an average annual rise of 4.2 percent
in the 1979-90 period. Growth in intermediate purchases dropped again to
2.2 percent per year during the 1990-2000 decade, however. Intermediate
purchases declined 5.5 percent in 2001.

From 1972 to 2001, intermediate purchase costs averaged 48 percent
of the total cost of inputs (see chart 3), the largest share of the
three inputs for the air transportation industry. Among intermediates,
fuel is the largest component. "The major U.S. airlines spend more
than $10 billion a year on fuel, which is approximately 10 percent of
total operating expenses." (41) Fuel costs fluctuated greatly over
the 1972-2001 period. Although fuel's share in the total cost of
intermediate purchases increased only slightly, from 30 percent in 1972
to 31 percent in 2001, the small rise obscures enormous fluctuation in
the interim years. Fuel's share in the total cost of intermediate
purchases rose from 29 percent in 1973 to 50 percent in 1979, spurred by
huge increases in the cost of fuel. The start of the enormous increases
in the price of fuel coincided with CPEC's (Organization of
Petroleum Exporting Countries) oil embargo that began in October of
1973. (42) By 1979, fuel made up one-half of the total cost of
intermediate purchases in the air transportation industry, and almost
one-fourth of total input costs; these numbers peaked in 1981 at 56
percent and 31 percent, respectively, as fuel prices continued to rise
during the 1979-81 period.

As a result of the increases in fuel prices, the airline industry
began to take measures such as lowering cruise speeds, using computers
to determine the optimum fuel loads, and using flight simulators instead
of aircraft to train pilots, among other things. In addition, the
industry began to invest "... billions of dollars in new aircraft
and engines that are far more efficient than the models they
replace." (43) By 1989, fuel's share in the total cost of
intermediate purchases had dropped to 28 percent; it then jumped again
to 34 percent in 1990, when the Persian Gulf crisis began, and dropped
to a low of 23 percent in 1998. Lately, some of the airlines have also
begun to hedge their fuel costs by entering into agreements with their
suppliers or by participating in the futures market.

Travel agent commissions, which have declined in recent years, are
another type of intermediate purchase. Until recently, travel agents
distributed 70 percent to 80 percent of tickets in the air
transportation industry. This proportion has been declining, however,
due to a changing operating environment in which air carriers are
reducing commissions while Internet competition is growing. (44)
Commissions paid out by establishments to travel agents followed an
upward trend from 1972 to 1993. Travel agent commissions rose 6.0
percent in 1993, when their share in the total cost of intermediate
purchases peaked at 22 percent. At one point, the airlines even began to
offer "override" commissions in addition to the standard
commission rate. Overrides are bonuses over and above the regular
commission if a travel agent sends extra travelers on a particular
airline. (45) For years, the airlines have been trying to reduce the
travel agent commission, one of the easiest operating costs to control
in the air transportation industry. The airlines have been reducing base
commissions and capping dollar amounts paid out to travel agents. (26)

The 1990s also brought important developments in computer-based
technology--and the Internet in particular--which played an important
role in the air transportation industry's distribution process. For
instance, since 1995, airlines have featured their own Web sites on the
World Wide Web. In addition to the airlines' own Web site, there
are third-party online outlets that specialize in online travel
bookings. Many airlines have joined an online travel site originally
created by four carriers in 1999, which has significantly increased the
level of competition in the online travel industry. This site offers
lower fares than its competitors because it eliminates the commissions
that are paid out to travel agents, which can add up to 5 percent of the
fare. (47)

Normally, because of a lack of detail on the types of assets being
leased, leased capital is included as part of the intermediate purchases
when measuring multifactor productivity for other industries published
by BLS. Due to its long history of government regulation, however, the
air transportation industry has kept very reliable data on leased
aircraft. Therefore, leased aircraft for this industry are counted in
the capital measure. Nonetheless, rentals other than aircraft
leasing--which are about 40 percent of total rentals--are another
important component of intermediate purchases in the airline industry.
Examples of rentals that remain in the intermediate purchases input of
the air transportation industry include ticket counter and baggage claim space in airports, among other things.

As of 2001, fuel, non-aircraft rentals, and total commissions--97
percent of which are paid out to travel agents--accounted for almost
one-half (47.3 percent) of the total cost of intermediate purchases. Of
the total cost of intermediate purchases, other services and outside
flight equipment maintenance accounted for 19 percent and 8.3 percent,
respectively, while passenger food and maintenance materials represented
5.9 percent and 5.4 percent, respectively. The remainder (14.1 percent)
was attributable to landing fees, communication, other materials,
advertising, and insurance.

Recent technological developments

Over the last decade, new technology has been developed that has
the potential to greatly improve the handling of air traffic.
Satellite-based technology revolutionized navigation and air-ground
communications in the air transportation industry during the 1990s. The
development of Global Navigation Satellite Systems such as GPS (Global
Positioning System) dramatically altered the operations of aircraft and
the air traffic control system. GPS consists of a constellation of 24
satellites circling the earth in six separate orbits at an altitude of
11,000 miles. (48) This system allows modern aircraft to know their
location to within a few tens of meters, and replaced Microwave Landing
Systems (MLS) as a precision approach aid. (49) GPS is considered
inaccurate, however, and too risky to be used in take-off and landing
situations, during which 50 percent of all aircraft accidents occur. A
variant of this technology, DGPS (differential GPS), "... uses a
fixed ground station to compensate for the inaccuracy of pure,
satellite-based GPS. The ground station calculates the difference
between its known location and where the satellites say it is, and beams
a correcting signal to incoming aircraft--allowing them to land with
pinpoint accuracy." (50) Moreover, a new technology called
Automatic Dependent Surveillance-Broadcast (ADS-B) developed in the
1990s allows the Air Traffic Control system to move closer toward free
flight. It is said to "... improve safety, ease congestion and
increase situational awareness by giving pilots and controllers
reliable, real-time traffic information." In addition to being able
to detect conflicting traffic, the users are able to determine the
direction, the speed, and the relative altitude of the traffic, allowing
them to react almost immediately to whatever changes occur in the
system. (51) Although ADS-B Can provide better aircraft surveillance
than radar, it is certified for awareness only. (52) It has not yet been
certified as a collision avoidance system, except in areas where there
is no radar. (53)

Airport capacity is one of the most significant issues facing civil
aviation. (54) Because building new airports can be more expensive than
expanding existing facilities, more attention has been given to the
latter. In addition to adding runways and taxiways, new technologies in
air traffic control systems can facilitate changing departure and
approach patterns. For example, ADS-B technology allows aircraft to
continuously broadcast digital data link signals of their GPS position.
(55) This provides access to real-time information simultaneously to air
traffic controllers and flight crews. (56) Therefore, ADS-B technology
can provide the ability to control aircraft without radar, which can
simplify the air traffic control system without compromising safety.
Moreover, this type of technology can facilitate decreased separation
between aircraft, and therefore, more flexible and fuel-efficient
routes. Tests show that it could have a very big impact on capacity,
where the biggest gains could come "... in marginal weather conditions and at night, when the air traffic system can get bogged down
as controllers cautiously build more space between planes." (57)

The current situation

Thanks to an improvement in the economy and a gradual recovery in
air travel demand, the air transportation industry has begun to see
signs of a recovery, after the industry's worst downturn following
the September 11, 2001, terrorist attacks. Overall, the major airlines
posted net losses of $7.4 billion in 2002 and $5.3 billion in
2003." (58) The major airlines, in particular, have made
significant progress. As a group, they have reduced their labor and fuel
costs and are slowly emerging from the effects of the recession and the
lingering aftermath of the September 11 attacks. For the third quarter
of 2003, for example, they increased their yield per available seat mile
by lowering capacity enough to offset a slight reduction in traffic,
thus producing high load factors and generating revenue. Moreover, they
cut labor costs and increased labor productivity, helping to reduce
their collective cost per available seat mile significantly. (59) The
future of air transportation remains uncertain, however, as airlines
continue to adjust to the realities of a new industry environment and
once again face high fuel prices.

The industry slump of the last few years has forced major changes
in air transportation. The low-cost carriers are continuing to take
market share away from the hub-and-spoke, legacy carriers. The route
structure of the low-cost carriers has grown large enough to provide
alternatives to travelers in almost all the large markets. (60) In
contrast, the mainline carriers, saddled by the higher cost of their
hub-and-spoke business models, have only begun to make inroads into the
restructuring of such systems. In order to effectively compete with
low-cost carriers, the legacy airlines must find a way to reduce their
operating costs. In addition to cost-cutting negotiations with their
labor unions, some of the hub-and-spoke carriers have introduced their
own low-cost subsidiaries to compete more effectively with the low-cost
airlines. Many industry analysts are skeptical, however, about the
effectiveness of setting up low-fare subsidiaries without resolving some
of the core problems at the major airlines. (61)

For many years the network airlines have relied on business
travelers to subsidize coach fares that are set marginally above
production costs. (62) Recently, there has been a shift in the buying
behavior of business travelers. Because of corporate budget cuts and the
increased availability of discount fares online, much business travel
has been re-priced. Business travelers have relied more on other means
of transportation such as alternate ground travel, charters and
corporate jets, low-fare carriers, and regional carriers. (63) In
addition, they have increased their use of communications technology such as high-tech videoconferencing and Webcasting--prices have fallen
and high-quality systems have continued to improve--as an alternative to
flying. (64) The intense competitive pressures within the industry seem
likely to continue in the near future. It remains to be seen how the
industry's structure will evolve from the interplay of the low-cost
carriers, the legacy carriers, and the latter's low-cost spin-offs.
However that evolves, generating productivity gains will continue to be
an important part of the industry's cost-containment efforts.

APPENDIX: Indexes of multifactor productivity

Most of the data used to develop the measures in this article are
maintained by the Bureau of Transportation Statistics (BTS) of the U.S.
Department of Transportation. The data are collected through a mandatory
monthly census and are defined by 'Form 41' carriers. (1) The
analysis of the airline industry is based on the passenger and cargo
operations of the scheduled and unscheduled airlines in the United
States. The BLS measure includes only the major and regional carriers.
(2) Indexes of multifactor productivity and related series are available
at http://stats.bls.gov/mfp/home.htm.

Output

The output of an industry generally consists of numerous products
or services that must be combined or weighted together in some
meaningful way. For constructing measures of multifactor productivity,
the preferred output index weights the difference, between times T and
T-1, in the natural logarithms of the quantities of all products or
services made in the industry with each product's share in the
total cost of production. The cost shares are constructed as the
arithmetic average of the share at time T and T-1. The exponentials
(antilogs) of the sums of the cost-share weighted changes are chained
together to form the index. This measure, known as a Tornqvist index, is
calculated with the following formula:

[[summation].sub.i]([S.sub.i]*(ln[([Q.sub.i]).sup.T-1]))

where i stands for individual products or services and T stands for
years, and where the cost share weights [S.sub.i] are calculated as:

where C is the unit cost of the product or service and Q is the
quantity.

The output measure for air transportation is a Tornqvist
aggregation of domestic passenger miles, international passenger miles,
domestic freight ton-miles and international freight ton-miles of U.S.
carriers. (3) Air couriers are classified in NAICS 4921 and are excluded
from the BLS measure. Data on passenger miles and freight ton-miles are
taken from the Air Carrier Traffic Statistics publication of the Office
of Airline Information, Bureau of Transportation Statistics, for all
Form 41 reporting carriers excluding couriers. Revenue data for the
weights are taken from Air Carrier Financial Statistics of the same
source.

Labor input

Average hours of employees in air transportation are not available,
and a constant workweek of 40 hours is assumed. The employment index
measures the change in aggregate employment over time. Although the
Current Employment Statistics program of the BLS does collect employment
data for air transportation, it does not match the production boundary
of the output data from the BTS. Consequently, the monthly employment
statistics for 'Form 41' carriers from the BTS are used. The
monthly data are averaged to create an annual figure, and then indexed.
Employees are treated as homogeneous and additive. Hence, changes in
qualitative aspects of employment such as in the skills, education, and
experience of persons constituting the aggregate, are not reflected in
the labor input indexes. (4)

Capital

The capital input index is based on the flow of services derived
from the stock of physical assets. For most industries, capital stocks
of equipment and structures are calculated from investment data by the
perpetual inventory method. For air transportation, this method is
followed for assets other than airframes and engines. However, the
perpetual inventory method was not used to measure capital stocks of
airframes and engines.

A physical count of end-of-year inventory of airframes and engines
and their purchase prices is reported annually on Form 41 (report number
B-43) to the Bureau of Transportation Statistics. The availability of
these data and the fact that investment data for airframes and engines
are somewhat problematic led to the use of weighted physical counts of
aircraft and engines by type to create capital stocks for these assets.
Problems with a perpetual inventory accounting of airframes and engines
include double counting of investment and premature retirement out of
the U.S. carrier fleet. Double counting of investment occurs when
aircraft are sold by the original buying carrier to another U.S.
carrier. In this case, the original investment remains in the capital
stocks until the end of the service life of aircraft and also is added
to the stock again when the second carrier buys the aircraft from the
first carrier. Premature retirement out of the U.S. carrier fleet occurs
when a U.S. carrier sells a plane before the end of its service life to
a foreign carrier. It remains in the perpetual inventory calculated
capital stock of U.S. carriers.

To compute a weighted index of airframes and engines, the
end-of-year inventories for 44 types of planes and 34 types of engines
were assembled from the B-43 reports for 1972 forward. All operating
airframes and engines are counted whether purchased, leased, or
capitalized leased. Purchase prices are also reported in the B-43
reports and are used as weights. The prices used were ones that were as
close to original purchase prices as possible, renormalized to base
years of 1977 and 1987 with the Producer Price Index (PPI) for aircraft
and the PPI for engines. The 1972-87 segment was aggregated with 1977
weights, and the 1987 forward segment was aggregated with 1987 weights.
New weights will be introduced periodically into the measure. The
perpetual inventory method was used for non-aircraft capital, which
includes assets such as surface transport vehicles, food service
equipment, ramp equipment, and maintenance buildings.

The perpetual inventory method was used to measure stocks at the
end of a year equal to a weighted sum of all past investments, where the
weights are the asset's efficiency relative to a new asset.
Constant-dollar capital stocks were thus calculated for the non-aircraft
assets. A hyperbolic age-efficiency function was used to calculate the
relative efficiency of an asset at different ages. The hyperbolic
age-efficiency function can be expressed as:

[S.sub.t] = (L-t) / (L-(B)t)

where:

[S.sub.t] = the relative efficiency of a t-year-old asset

L = the service life of the asset

t = the age of the asset

B = the parameter of efficiency decline

The parameter of efficiency decline was assumed to be 0.5. This
parameter yields a function in which assets lose efficiency slowly at
first, then more rapidly later in life. The end-of-year stocks were
averaged at T and T-1 to represent better the value of stocks actually
in use during the year.

The value of inventories of parts and supplies is also included in
capital stocks. This value was calculated by averaging, at years T and
T-1, the end-of-year stocks of parts and supplies deflated by an average
of the PPI for fuels and the PPI for aircraft parts and equipment.

The indexes for aircraft and engines, non-aircraft assets, and
parts and supplies inventories were aggregated into an overall measure
of capital input using cost shares based on estimated rental prices as
weights. A perpetual inventory calculation of aircraft and engines was
performed for the purpose of calculating an internal rate of return.
Rental prices for non-aircraft assets and for inventories of parts and
supplies were calculated as:

The rental prices were calculated in rates per constant dollar of
productive capital stock. Rental prices for non-aircraft assets and
parts and supplies inventories were multiplied by their constant-dollar
capital stocks to obtain current-dollar capital costs, which are
convetted to cost shares for Tornqvist aggregation of the capital input
index. The capital costs of aircraft and engines were derived by
subtracting non-aircraft asset costs and parts and supplies inventory
costs from total capital costs.

Intermediate purchases

The input of intermediate purchases includes the materials, fuels,
electricity, and services consumed by air carriers. Detailed cost of
materials data were available for 21 items for the years 1972-1986 and
for 13 items for the years 1986-2001 from the Form 41 reports. Each item
was matched as closely as possible to a Producer Price Index (PPI). For
aircraft fuels and oils, data on gallons consumed were used. The
detailed values were then deflated and the resulting constant-dollar
values were Tornqvist aggregated.

Combined input index

The index of combined inputs is calculated as a Tornqvist
aggregation of the input indexes of labor, capital, and intermediate
purchases. The cost share weights were calculated by estimating the
annual nominal dollar cost of each, summing them and dividing each
input's cost by the total. The costs of aircraft rentals in the
intermediate purchases data were moved into capital costs because rented
aircraft are counted in the capital measure. Other rentals (for example,
ticket counter space in airports) remain in the intermediate purchases
input. The relative cost share weights for the three inputs are listed
below for various years.

(1) "Form 41" reports contain information on large
certificated U.S. air carriers, defined as those that hold a certificate
issued under section 401 of the Federal Aviation Act of 1958 and that
generate operating revenues that exceed $1 billion.

(2) The commuter airlines do not file "Form 41," which is
the source of capital data. Thus, they are excluded from the BLS
measure. See the Web site www.rspa.gov for the definition of Form 41,
which is the basis for the data set used in this article.

(3) A figure for passenger miles is computed by multiplying the
number of passengers by the number of miles flown. Similarly, a figure
for revenue-ton miles is computed by multiplying the number of freight
and mail tons being transported by the number of miles flown.

(4) The effects of changes in workers' characteristics are not
reflected in the labor input indexes. See Labor Composition and U.S.
Productivity Growth, 1948-90, Bulletin 2426 (Bureau of Labor Statistics,
December 1993). The bulletin uses data on worker heterogeneity in the
examination of productivity growth in the private business and private
nonfarm business sectors. However, reliable data on workers' traits
are not available at the industry level, and hours must be treated as
homogeneous and additive in the industry labor productivity measures.

(1) U.S. Department of Transportation, Bureau of Transportation
Statistics, as reported by the 2001 National Household Travel Survey,
preliminary distance file, on the Internet at http://
www.bts.gov/publications/national household travel survey/ highlights of
the 2001_national_household_travel_survey/ html/table_04.html.

(13) Delta, "THE PLANE TRUTH," p. 4, on the Internet at
http://www.delta.com/pdfs/plane_truth.pdf.

(14) Hubs are strategically located airports used as transfer
points for passengers and cargo traveling from one community to another.
They are also collection points for passengers and cargo traveling to
and from the immediate region to other parts of the country or overseas.

(23) Although the composition of labor input may be influenced by
changes in factors such as training, experience, and education, the data
used in this article treat labor input as a homogeneous factor. Thus,
employees are added with no distinction made between workers with
different skill levels or wages. The effects of changes in labor
composition are included in the productivity residual. See labor input
section in the appendix for additional information.

John Duke is a supervisory economist, and Victor Torres is an
economist, In the Division of Industry Productivity Studies, Office of
Productivity and Technology, Bureau of Labor Statistics; Paul Kern,
formerly with the same office, also contributed to the calculation of
the measures presented here,

E-mail: Duke.John@bls.gov Torres.Victor@bls.gov

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